Indonesia's Economy

After ten years that were focused largely on intra-Indonesia affairs, the largest concern at present (late 2008 at the time of this writing) comes via the likely fallout from the United States' mortgage-cum-banking debacle. Even though the problems are currently restricted mostly to America - the exception being global stock markets - there are major concerns across the world map. Projections for the financial systems of Europe, Japan and the U.S. are at their lowest ebb in at least a decade.

Economic growth in America and Europe are virtually stagnant and several economists have made some rather bearish predictions. If America slips into a deep recession, Asian economies, particularly the emerging economies of ASEAN, may be able to weather the storm. Seemingly in defiance of the gloomy global economic outlook, Indonesia has had back-to-back years of growth at levels close to the economic boom years of the mid-1990s before the economic crisis of 1997-1998 hit. Indonesia is set to end 2008 with some 6.5 percent growth, and some indicators point to an even better year in 2009; however that will depend on oil prices coming down and how much exposure the country has to the U.S. recession.

The politics behind the economy

Susilo Bambang Yudhoyono convincingly won the presidency in September 2004 and confidence in him, by investors and consumers, has remained generally positive.

Since 2005, direct regional elections for governors and mayors have been running in a generally smooth manner as rural and urban Indonesians become more adept at campaigning, assessing candidates and voting intelligently. Problems remain with sporadic vote-buying, intimidation and sometimes lack of decent candidates from which to choose, but most international electoral pundits consider the overall process to be positive.

In the aftermath of the devastating tsunami in Aceh (December 26, 2004), the Yudhoyono administration took advantage of a window of opportunity to engage in concerted peace talks with the Acehnese rebels. In August 2005, a historic peace agreement was signed. The natural resource-rich province can now focus on rapid economic recovery and development as political tensions have subsided immensely.

After winning a virtual tug-of-war between fiscal fundamentalists and social program spenders, Yudhoyono was able to push through two tough subsidy-slashing packages in 2005. The cuts effectively raised gasoline, diesel and kerosene prices to unprecedented levels across Indonesia. There were street rallies in opposition, but the government was able to weather those with an educative approach, while calmly enlightening the nation's citizens on the medium- to long-term economic necessity of the fuel hikes.

Similarly, there were large street rallies by laborers in April and May 2006. They were protesting a pro-business amendment (or, in the words of the central bank's then-chief Dr. Miranda Goeltom: "The jobs creation law.") to the heavily pro-labor laws of 2003, but Yudhoyono restored order by promising to negotiate with all stakeholders. He called for a series of tripartite meetings - made up of representatives of the government, employers and trade union representatives - to work out the best possible deal and eventually reached an agreement seen as mutually beneficial for each side.

Higher fuel prices and the resulting double-digit inflation in 2005 and 2006 increased pressure on Yudhoyono to make some changes to his economic team, with much of the focus on then-coordinating minister for the economy Aburizal Bakrie. Yudhoyono appointed Boediono in December 2005, the former finance minister in the Soekarnoputri government, to replace Bakrie. The President also replaced finance minister Jusuf Anwar with Sri Mulyani Indrawati. Many commentators in the local media were quite pessimistic about Yudhoyono's ability to manage the inevitable opposition to the subsidy cuts. However, he and his team have proven resilient over past three-plus years, and while there have been several natural disasters during his time in office - the aforementioned tsunami, earthquakes off central Java, Jakarta floods, a volcanic eruption and a "mud volcano" in East Java - the president has come through relatively unscathed, but not without some criticism.

Still others doubted the government's political will to battle corruption, but, again, the president and his Cabinet have shown that they have the will to clean up the nation's key institutions through rule of law, even if ‘real-politic' often dictates a slightly slower, more tactful approach than what anti-corruption activists want. After receiving its mandate in 2004, the Corruption Eradication Commission, with special prosecutors that can investigate cases involving losses of more than Rp 1billion, and have wide-ranging power, have started to uncover and resolve a host of high-profile graft cases. The most notable being the cases involving Governor Puteh and the top officials of the General Elections Commission. Indonesian Corruption Watch director Teten Masduki remains cautious on the graft battle, despite some successes, "We must be vigilant in the years to come. If the anti-corruption program is only symbolic in nature, merely aimed at maintaining popularity, but devoid of a true spirit to create good governance, it will not work. If it is not designed as a massive national movement to mobilize all government resources, (including) the public and the business sector, then there may not be significant progress from what has been achieved so far."

The President himself established the inter-departmental anti-corruption team in early 2005. The team has a mandate to clean up the bureaucracy. They have vowed to resolve nearly two dozen graft cases at ministries and state-owned enterprises by the end of 2006. The team has had mixed success and managed to bring to justice high-level officials from the Religious Affairs Department for fund misappropriation and recover over a billion dollars.

In addition to a cohesive Cabinet and generally pro-administration House of Representatives, or DPR, the 2004 polls also saw the election of four "senators" from each province, who now have the responsibility to create a vibrant bicameral legislature able to act as a second effective branch of the newly democratized governmental system.

The Regional Representative's Council (or DPD) was established in 2001 under the Constitution as a second parliamentary chamber. With the political changes that have taken place in Indonesia - particularly the greater authority given to provinces under the 2001 autonomy laws - the DPD is expected to play an important role in relaying regional ideas on policy to the central government, while assisting in the smooth implementation of regional autonomy. Thus far, critics have charged that the DPD has been largely ineffective, but that will not last long because Indonesian voters have begun to realize the power they hold, and if their DPD members have not done enough, someone else will be elected in his/her place in 2009. While Yudhoyono is a relatively popular president, his new party, the Democratic Party, is only the third largest in parliament. However, his vice president, successful businessman Yusuf Kalla, is the leader of the Golkar party, which has the largest percentage of seats in parliament, and as a result, most of this administration's policies can eventually get pushed through.

Implications for investment

Since the massive financial fallout of 1997-1998, in which Indonesia's economy contracted by 13.2 percent in one year and currency weakened more than 5-fold, the past nine years have seen some of the toughest times in the nation's 6-decade history. Economic recovery has been slow, but in the past two years has become very solid, with GDP growth averaging 5 percent in recent years. Now, however, nearly every economist believes that the road to full recovery is imminent. The economy is now moving forward, although few would argue that there are no more risks. The means by which investors interact with the newly reformed business and political actors have become clearer. Yudhoyono's economic team has been resoundingly approved of by investors, especially after a Cabinet reorganization in late 2005, which ushered the highly respected Boediono back into the Cabinet as the powerful coordinating minister for the economy. Solid fiscal governance since the end of the Soeharto administration in 1998 has cut in half the government's debt ratio to below 50 percent of GDP. The IMF noted in a glowing report on May 19, 2006 that Yudhoyono's team would more than likely cut it to 30 percent by 2009.

Boediono's job is made easier by the very capable Finance Minister Sri Mulyani Indrawati, who has a doctorate in economics from the University of Illinois, and was the executive director of the International Monetary Fund representing 12 economies in Southeast Asia. She boldly fired the heads of the taxation and customs agencies in April 2006 and replaced them with career technocrats renowned for their integrity. Boediono and Indrawati are supported in their efforts by central bank governor Barhanuddin Abdullah. Boediono has served in many senior government positions, and was minister of finance for three years, mainly during the Megawati administration. Probably more than any other person, he was responsible for the restoration of macroeconomic stability. Public debt began to rise alarmingly following the economic crisis. He managed to bring the budget deficit to just 1.5 percent of GDP, an achievement that would have been viewed as nearly impossible in the late 1990s.

Moreover, he did it despite a lot of opposition from his fellow Cabinet members in the last administration, as well as the House - particularly to the tight fiscal measures called for by the IMF, from which Indonesia has since graduated. The nation's economy has been on a fairly steady upward trend since 1999, characterized by moderate, but encouraging growth, over the past eight years, and has been strong enough on the fundamentals to weather several potential crises, including terror blasts, massive natural disasters, large-scale government subsidy cuts and major health risks, such as Avian Flu, and earlier, SARS. Despite these setbacks, growth has hovered well above 5 percent per annum, and expectations and targets for the next five years have ranged from 6- to 8-percent growth.

Consumer prospects

The potential for greater consumer buying power is very encouraging, not only has Real GDP per capita returned to and exceeded pre-crisis levels in recent years, but also because it has happened despite an overly high current rate of unemployment and underemployment - the reduction of which has become a high priority of the Yudhoyono administration. They have put a particular emphasis on and redoubled efforts to boost both private and public investment, largely on public works projects and mega-infrastructure projects to create jobs; thereby greatly improving purchasing power for hundreds of thousands of families across the archipelago.

And with better roads, railways, ports and electricity, international investors should be sufficiently attracted to set up shop here, thus employing even more potential consumers. While the market and media commentators have roundly applauded each minister and his/her credentials, much work remains to be done in the lower echelons of the ministries. A case in point is the avian flu pandemic. The health minister, Siti Fadilah Supari, has very solid credentials, knows full well what steps must be taken and is largely in agreement with W.H.O. on those steps; however, she has often complained of an inability to motivate mid-level bureaucrats in the health department and in the provinces to carry out the tough, but necessary steps, to combat the disease. (She has also defied global pressure on the issue of sharing virus samples, but we won't delve into that here). Similar implementation problems prevail throughout much of the bureaucratic system, despite new regulations and forward-thinking department heads and ministers.

Outlook 2009

Political leadership is guiding economic forces toward improving macroeconomic management, better allocation of resources, higher real incomes and a more equitable distribution of wealth. The president enjoys broad popularity, even though it has been in decline from late 2005. There is another election in 2009, and with the opposition splintered and confused, Yudhoyono still has a lot of time to regain lost ground in terms of overall approval ratings. Despite tighter money, cuts in subsidies, budget re-allocations and delays in major reforms, the economic fundamentals are solid with macroeconomic indices under control, oil and gas activity slightly up and the shift from the over-burdening subsidies to a sustainable social safety net. The major concerns for Indonesia's economy don't, in fact, come as a result of the American crisis, but from the impact of the skyrocketing cost of oil, which is a direct hit on the government's coffers via the untenable fuel subsidy (even though that was slashed significantly in 2005).

There is also the problem of inflation pressures on domestic prices, which will especially hurt the poorer classes and will most certainly jeopardize the revival of consumer expenditures. Consumer spending remains one of the main driving forces of the nation's economy. The main focal points for government policymakers and Minister Boediono are to mitigate inflationary pressures, keep a tight lid on the budget deficit - which could mean another big fuel subsidy cut - and increase expenditures in infrastructure. Reaching these goals would buttress consumer and investor sentiment and attract new business.

Despite deep uncertainty across the world's financial centers, particularly Wall Street, Indonesia's investment climate could actually improve well through 2009, especially if President Yudhoyono wins the election and keeps his current economic team relatively intact. Consumer sentiment will likely drop a bit, that's to be expected. Infrastructure investment by the government and/or private investors will create new jobs and growth should be at or above 6 percent again throughout 2009.